Seventh D.P. Kohli Memorial Lecture on
Economic Growth and Issues of Governance
by
Dr. C. Rangarajan
Chairman
Economic Advisory Council to the Prime Minister
June 1, 2006
New Delhi
Economic Growth and Issues of Governance
1.It is a great privilege to deliver the seventh D.P. Kohli Memorial Lecture. Economists talk of infrastructure development as the key to economic progress. Infrastructure is broadly conceived as comprising social infrastructure which includes facilities in health and education and physical infrastructure which includes investment in, for example, power, transport and communications. However, an important part of the infrastructure is the existence of a good legal system without which a modern society cannot function. A good legal system requires in turn an impartial investigating agency to facilitate the dispensation of criminal justice. It is this important role that the CBI is playing in India’s democratic polity. Over the years, the CBI has established a reputation for professionalism and competence. There is a growing demand on the Agency to take up investigations of various types. The CBI in its present form owes very much to the vision of its founder-director, the late Shri D.P. Kohli. Among the attributes required of a good police officer are leadership, integrity and professionalism – three attributes that best describe the Late Shri D.P. Kohli in whose honour and memory we are assembled here today.
2.A review of the economy in the recent period throws up several interesting insights. Economic growth has averaged 8 per cent per annum over the last three years. Our external payments situation is comfortable, foreign exchange reserves are robust, inflation is benign, the investment climate is promising and our comparative advantage in the knowledge economy is fueling the boom in the service sector. Social indicators have improved too. Life expectancy has gone up as have indicators in health and education. A child born today can expect to live 25 years longer, hope to be more educated, and lead a healthier and more productive life than a child born at the time of independence. Indeed, if we can sustain an average annual growth rate of 8 per cent, the child of today will see the per capita income of the country multiply more than four fold by the time she grows up to be 21.
Challenges Ahead
- Yet there are many challenges on the way forward. We need to sustain the present rate of growth, if not accelerate it to higher levels. We need to translate growth into poverty reduction. In other words, we need to generate poverty reducing growth – i.e. growth to which
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I am grateful to Dr. D. Subba Rao who made a substantial contribution to the writing of this paper.
the poor contribute and from which the poor benefit. We need to expand employment opportunities and improve productivity across all sectors of the economy. We need to narrow economic disparities across and within states without compromising on efficiency. We need to improve on social indicators too; India still ranks a low 127th in the UNDP’s Human Development Index in the bottom third of the league of nations. The agenda for achieving growth and poverty reduction is formidable requiring as it does focus not only on identifying priority areas for action but also on effective and efficient implementation of the policy agenda. In other words, we need to focus simultaneously on economic growth and on governance. I want to use the opportunity that you have so kindly provided me to reflect on the broad contours of this theme - Economic Growth and Good Governance.
1991 Reforms - Genesis
4.In the post-independence economic history of our country, 1991 is a watershed year. This was the year in which the economy was faced with a severe balance of payments meltdown. In response, we launched a broad ranging economic programme not just to restore the balance of payments but to reform, restructure and modernize the economy. This was entirely appropriate for the external payment crisis was just the proximate manifestation of a policy regime that has, over the years, tended to give precedence to command and control over productivity, efficiency and entrepreneurship. In the event, the 1991 reforms signaled a shift away from the earlier paradigm.
Economic Reforms - Break with the Past
5.This break with the past came in three important directions. The first was to dismantle the complex regime of licences, permits and controls that dictated almost every facet of production and distribution – what to produce, where to produce, how to produce and how much to produce. The entrepreneur has now greater freedom to decide on all these choices. The second change in direction was to reverse the strong bias towards state ownership of means of production and proliferation of public sector enterprises in almost every sphere of economic activity. Areas once reserved exclusively for the state have been thrown open to private enterprise. The third change in direction was to abandon our inward looking trade policy. This elusive, and in hindsight ill-advised, quest for self-sufficiency was driven by a belief that there was a value to minimizing the economy’s external dependence and producing what we need ourselves even if it meant high costs and low efficiency. By embracing international trade, India signaled that it was abandoning its export pessimism and was accepting the challenge and opportunity of integrating into the world economy.
Rationale Underlying Reforms
6.Although the various elements of the reform agenda may look disparate, there is an underlying rationale running across the broad swathe of economic reforms. This was to give a greater market orientation to the economy and to let the competitive forces and growth impulses that are the bedrock of a modern, dynamic economy to come into fuller play. Liberalization removed the barriers to entry and relaxed the plethora of restrictions on production and distribution. Deregulation brought about a more competitive domestic environment while the liberalized trade and foreign investment policy sought to improve international competitiveness. By reducing its entrepreneurial role, the government was yielding economic space to the private sector while also redefining the role of the state.
Stabilization and Structural Adjustment
7.Conceptually, the economic reform agenda can be divided into two strands – stabilization, aimed at redressing the internal and external imbalances in the economy, and structural adjustment aimed at removing the rigidities and inefficiencies in the system and improving its competitiveness. Thus, stabilization can be attempted and completed quickly while structural adjustment is a medium to long-term process. Stabilization is macro-economic in content while structural adjustment encompasses both macro and micro-economic aspects. While stabilization could be managed by the government acting on its own, structural adjustment is much broader and deeper in scope requiring the proactive involvement of the government at various levels and the people at large.
Uniqueness of India’s Reforms
8.India’s economic reforms are unique in two important respects – not because of the content of the reforms but because of the context in which we are pursuing them. First, we are implementing reforms in a democratic context, no matter that it has many flaws. Second, we are pursuing reforms in a decentralizing context. This democracy-federalism context oftentimes has meant restraint, even compromise, deliberate decision-making and slow progress. While there are many respects in which we can make our approach to reforms more efficient and purposeful, in an overall perspective, it must be acknowledged that making haste slowly – ‘crossing the river by feeling the stones’, as the Chinese say - has a lot of merit. The participatory and consultative processes inherent in our institutions of meditation and restraint have added to the credibility and robustness of our reforms.
Post-reform Growth Performance
9.That the content and process of our economic reforms are on the right track is vindicated by the performance of the economy since the launch of the reforms. Between 1981-82 and 1990-91, i.e. the decade before the reforms, the economy grew at 5.6% on a compound average basis. The year 1991-92 was an outlier because of the balance of payments crisis, and should therefore be omitted for the purpose of discerning trends. In fact, there is every justification for including it in the pre-reform period because it was also a culmination of the policies pursued previously. The effect of the reforms should be judged starting with the economy’s performance in 1992-93. Between 1992-93 and 2004-05, the economy grew at 6.2% on a compound average annual basis, a significant improvement over the pre-reform record. The growth rate was 8.5% in 2003-04, 7.5% in 2004-05 and is expected to cross the 8% mark in 2005-06. It is clear that India has shifted to a higher growth trajectory.
Six Challenges on the Way Forward
10.At the same time if we are to sustain this rate of growth, and in fact accelerate the growth rate to higher levels and translate that growth to broad-based poverty reduction, we must address some important challenges. I want to reflect on what I think are six of the most important challenges warranting priority attention.
1st Challenge - Stepping up Agricultural Growth
11.First, we need to step up the growth rate of the agriculture sector. We have come a long way from the chronic food shortages and occasional famines that marked our pre-independence and immediate post-independence history. That we have achieved near self-sufficiency in food is a remarkable achievement. Yet it must also be admitted that our agriculture is characterized by low productivity both of land and labour. The most critical problems are low yields and the inability of the farmers to exploit the advantages of the market because of lack of infrastructure to transport the produce from the farm to the market. Clearly we need to modernize and diversify our agriculture sector by improving both the forward and backward linkages. These will include better credit delivery, investment in irrigation and rural infrastructure, improved cropping pattern and farming techniques and development of food processing industry and cold chains across the entire distribution system. Agricultural growth is critical for expanding employment, generating broad-based growth and sustained poverty reduction.
2nd Challenge - Infrastructure Development
12.The second critical constraint to growth is the infrastructure deficit, more particularly, in power. The infrastructure needs of the economy are large because of the demand generated by economic growth, rise in population, rapid urbanization as well as the need for making up the accumulated backlog. Provision of infrastructure was once considered to be an exclusive responsibility of the government. Advances in technology which have made unbundling possible, as well as innovative financial products have changed the characteristics of infrastructure provision making both private sector participation as well as competition possible. In order to mobilize the necessary resources and build quality infrastructure, we need to put in place appropriate legal, regulatory and administrative frameworks to attract domestic and foreign investment. We also need to address issues of pricing and cost recovery, with subsidies where required, being made transparent and explicit. This in turn will require the establishment of credible regulation for ensuring fair competition across public and private operators, and for protecting consumer interest, public safety and environmental integrity.
3rd Challenge - Fiscal Consolidation
13.The third critical challenge on the way forward is fiscal consolidation which is a necessary prerequisite for sustained growth. Excessive fiscal deficits can disempwer the government in important ways. The finances of the state governments are particularly under greater pressure. The appropriate level of fiscal deficit has a relationship to the level of household savings in financial assets. Even as of now, very nearly the whole of the household savings in financial assets is appropriated by the public sector. The argument that government expenditures should shift in favour of capital expenditure is valid. Unfortunately, the trend has been in the reverse. Containing the growth of current expenditures – what we commonly call revenue expenditures – is critical. Admittedly, in a developing economy like ours where a significant proportion of the people are poor, subsidies provide a safety-net and are an essential component of public expenditure. However, subsidies need to be targeted appropriately so that they accrue only to the deserving. We must avoid the temptation to extend subsidies indiscriminately. We must make an effort to evolve a consensus on rationalizing subsidies and user charges and reducing revenue expenditures.
4th Challenge - Building Social Infrastructure
14.The fourth important challenge to growth is investment in social infrastructure – particularly in the twin merit goods of primary education and basic health. There are any number of studies that establish a positive correlation between low levels of poverty and improved indicators of health and education. We need to spend more on education and health. But we also need to spend more efficiently because better education and health are a function not just of the quantum of expenditure but also of the quality of that expenditure.
5th Challenge - Managing Globalization
15.Next on my list is the challenge of globalization. Globalization has been a contentious issue, and a topic of often-acrimonious debate as also high profile protests. The scope of this lecture does not permit me to address in detail all the issues surrounding the debate on globalization. What I do want to emphasize though is that our economies are no longer defined by political boundaries. Globalization, defined as the free movement of goods, services, ideas and people across borders, is here to stay. No revolution in human history has been totally benign. So it is the case with the globalization which comes with costs and benefits. We cannot wish away globalization, nor can we shut our doors and remain indifferent. The only option is to manage globalization in such a way as to maximize the benefits and minimize the costs. Consider for example our head start in the knowledge economy. We got off the block here ahead of other countries because of our superior technical manpower. But other countries are fast catching up and our comparative advantage will be threatened unless we are continuously ahead of the curve in terms of technical sophistication and competence levels. More than many other developing countries, India is in a position to wrest significant gains from globalisation. Even as we make efforts to modify the international trading arrangements to take care of the special needs of developing countries, we must identify and strengthen our dynamic comparative advantages.
6th Challenge - Good Governance
16.Just to recap, the five challenges on the way forward to accelerating growth and poverty reduction that I have addressed so far are: stepping up agriculture growth, infrastructure development, fiscal consolidation, enhancing the quality and reach of primary education and basic health, and managing globalization. Identifying these challenges and drawing up plans to address them is the relatively easy part. What is infinitely more difficult is the translation of those policies into action. That brings me to the sixth and final challenge that we need to confront - the issue of governance.
Evolution of Thinking on Economic Development
17.That good governance is at the very heart of economic growth and poverty reduction, and even political legitimacy, is now part of conventional wisdom. However, we did not zero in on this intuitively. The realization that good governance is critical came as a result of some profound changes in development thinking over the past 50 years. In the 50s and 60s, when many countries of Asia and Africa were emerging out of colonialism, the path to development, it was widely believed, lay in capital formation. In the 1970s, awareness grew that physical capital was not enough, and at least as important was fulfilling basic human needs. When this too did not produce results, the missing link, it was thought, was improving social capital through education and health. Yet again there was no breakthrough. The disappointing experience with the debt crisis in Latin America and chronic poverty in Sub-Saharan Africa and South Asia during the ‘lost decade’ of the 80s threw up the idea that the path to development lay in improving economic management and giving greater play to market forces. Again the results were mixed. Some countries such as those in Latin America posted disappointing results in spite of making the transition to the market fully; on the other hand countries in East Asia performed well despite deviating in important ways from the market model. What made the difference was institutions of governance. The received wisdom is that, for growth and poverty reduction, we need physical and social capital, we need to focus on basic needs, and we need to yield to the market forces in a calibrated manner. These are all necessary, but not sufficient. They will not yield results unless they are accompanied by good governance.
What is Good Governance?
18.What is good governance? As per textbook definition, good governance is the manner in which the authority of the state is exercised in the management of a country’s economic and social resources for maximizing welfare. In the ultimate analysis, it is the quality of governance that separates success and failure in economic development. Across countries, application of the same policies in roughly similar contexts has produced dramatically different results. In our own country, we have seen vast differences across states in development outcomes from out of the same mix of development policies. These differences across countries as well as across regions within countries, even as they adopt similar policy packages, arise because of differences in governance. Indeed research shows that per capita incomes and the quality of governance are strongly correlated indicating a virtuous circle in which good governance results in economic development.